How to Set Up Your Own Indicator – Patterns

If you’ve read the previous articles of the How to Set Up Your Own Indicator series, you’ll know how indicators work, and specifically that they target patterns. Patterns offer a certain amount of predictability, and that leads us to have winning trades.

Something to keep in mind, though, is that looking for these patterns is exactly what every other trader is doing as well. These indicators are quite popular for a reason, and if a lot of people are using the same indicators, that’s going to have an impact on the market. How do you account for that in your set up?

The problem of crowding

Let’s say there is an event that can be predicted in the market. For example, if the USDCHF reaches 1.2000, the SNB will intervene, and push the pair down – a hypothetical scenario.

Since everyone (especially the big traders) knows this is going to happen, people then want to get in ahead of the move because if they wait too long, they’re going to miss it.

So, as the market gets near the 1.2000 level, people start putting in sell orders, pulling the market down. Ultimately, it never actually ends up meeting that point.

If you had set up your strategy banking on selling at 1.2000, it was not going to work. Even though you have very accurate information; the fact that everyone else has the same information means that the market behaves differently.

A similar phenomenon happens with indicators; if one, in particular, is really good, eventually there will be enough people using it, trying to get ahead of it, that the moves it’s “predicting” won’t actually materialize.

After all, if there were a foolproof way of predicting the market, then there wouldn’t be a market at all since everyone would already know what is going to happen.

So, how do we deal with this problem? Well, there are two ways, generally speaking.

The lone wolf trader

Often traders will try to get an edge on the market by doing something different. This takes creativity, hard work, and quite a bit of trial and error. Basically, they are looking for a better system than what everyone else is already using, one that will allow them to find patterns that others aren’t seeing, or maybe look at the patterns before others do.

These traders go for the really exotic indicators, or an eclectic mix of them, or even come up with their own. All the indicators that we have were created by people who were unsatisfied with the tools that existed at the time and thought they could figure out a better one.

How successful this is will depend on how good you are at creating an indicator, or a system. Who knows, maybe you’ll come up with an idea that will shift the trading paradigm. Or perhaps you’ll be a little more modest, and consider the second option.

The pack hunter

If you can’t beat them, join them, they say. There are some indicators that are very popular for a reason: they work pretty often. Often enough for some people to trade professionally. After all, to be a successful trader, you don’t have to beat the whole market; you just have to be consistently profitable enough to be worth the investment.

This outlook tends to work well with retail traders because they aren’t trading so much to move the market, so it’s entirely possible to go with the flow and shave off quite a handsome amount of pips from the market.

The idea is to use a standard set of indicators to have a general idea of where other traders are positioning and using the self-fulfilling prophecy nature of common market indicators to improve their trading. How that works, we’ll get into in the next article.

Of course, no one is purely a lone wolf or a pack hunter. If you are trying to get trades in that others aren’t, you have to know what others are doing; and if you are going along with the flow of the market, you want to get a bit of an edge in order to not be the last to jump on the move. However, ultimately you’re going to be focusing more on a uniquely personal setup; or using a setup based on a tried and perfected system.

Daniel John Grady is a financial analyst and writer. He is a former CFO with a degree in Financial Management and has been published in both English and Spanish. With over ten years of equities trading experience, he is primarily interested in foreign exchange and emerging markets with a focus on Latin America.

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